By The Clifford Group

Deferred compensation plans often sound more complex than they really are. At their core, they represent a way for professionals to set aside earnings today with the goal of receiving them later, usually during retirement. For high-net-worth individuals and executives, these plans can be powerful tools to manage income, reduce current tax burdens, and align financial planning with long-term goals. The challenge is that they come with important trade-offs and considerations. Understanding the balance between benefits and risks is essential for making informed choices.

What Deferred Compensation Really Means

Deferred compensation is an agreement between an employer and an employee in which a portion of income is set aside to be paid in the future. The most familiar example is a retirement plan such as a 401(k). Nonqualified deferred compensation plans, however, often go beyond the standard retirement structure. These plans may allow executives to defer a significant portion of salary, bonuses, or other incentives. Unlike qualified plans, they do not have the same contribution limits, which makes them especially appealing to those with higher incomes who have already maximized other retirement vehicles.

The Appeal for High Earners

For many executives, the immediate attraction of deferred compensation is tax deferral. By postponing income, participants may reduce their taxable income in high-earning years and potentially withdraw funds later at a lower tax rate. This can create significant savings over time, especially for those planning to step back from their careers or shift into lower-paying roles later in life. Deferred compensation can also serve as a structured form of forced savings. In professions where bonuses are large and irregular, the discipline of deferral ensures that some of today’s income is preserved for tomorrow.

Key Risks to Keep in Mind

While the appeal is strong, deferred compensation is not without risk. Unlike a qualified retirement plan, these accounts are typically unsecured obligations of the employer. That means the funds are not held in a separate trust protected from creditors. If the company experiences financial trouble, the deferred compensation could be at risk. This is often referred to as “creditor risk” and is one of the most important considerations when evaluating such a plan. Liquidity is another factor. Deferred compensation is not designed for early access. Once income is deferred, participants generally cannot change their minds without facing penalties or forfeitures. The lack of flexibility can create challenges if personal circumstances change unexpectedly.

Timing Is Everything

Decisions about when to receive deferred compensation payments are often as important as the decision to participate in the first place. Payouts can sometimes be scheduled for retirement, for a specific future year, or over a defined period. Choosing carefully matters because it impacts tax exposure and cash flow. Large lump-sum distributions may create an unintended tax burden, while stretching payments over time may smooth taxable income. Coordinating payout elections with retirement planning, investment strategy, and other sources of income creates a more cohesive approach.

Comparing to Qualified Plans

Many executives already contribute to 401(k) or 403(b) plans. Deferred compensation plans serve a different purpose and should be evaluated in that context. Qualified plans have strict contribution limits but are generally protected from employer insolvency. Deferred compensation plans, in contrast, allow for much larger contributions but carry greater risk. The two are not competitors; rather, they complement one another. Maximizing qualified plan contributions first is often a prudent step before engaging in more complex deferral strategies.

The Human Side of Deferral

Numbers and tax tables only tell part of the story. Deferred compensation is about more than financial mechanics. It is about creating peace of mind and aligning resources with what matters most. For some, that means securing a stable retirement. For others, it means knowing that family obligations, philanthropic goals, or lifestyle choices will be supported well into the future. Making these choices often stirs emotions because they involve balancing present enjoyment with future security. It requires asking questions such as: 

• Will I value having this income later more than I would today? 
• What risks am I willing to accept for the chance of greater tax efficiency?

Coordinating with Broader Planning

Deferred compensation should not be considered in isolation. It intersects with estate planning, tax strategy, investment allocation, and even decisions about career trajectory. For example, executives nearing retirement may want to align distributions with when they expect other assets, such as stock options, to be exercised. Families with multigenerational planning goals may consider how deferral choices interact with trusts or charitable strategies. Working with financial and tax advisors can help integrate deferred compensation into a larger plan that reflects personal values and objectives.

Common Mistakes to Avoid

Many professionals fall into predictable traps with deferred compensation. Some focus solely on tax savings and overlook the importance of company stability. Others choose payout schedules without considering the potential impact of future tax law changes or personal income needs. Waiting too long to review deferral options is another common issue, since decisions often must be made before the income is earned. Awareness of these pitfalls can help prevent costly missteps. A thoughtful, proactive approach is always more effective than reactive decision-making.

Questions Worth Asking

When evaluating a deferred compensation plan, consider starting with a few key questions. 

• How financially strong is the company offering the plan? 
• What options exist for timing distributions? 
• How do these choices align with retirement plans, lifestyle goals, and tax strategy? 
• What level of flexibility exists if circumstances change?

These questions can open up a deeper conversation and create a framework for making decisions that feel both rational and emotionally reassuring.

Turning Complexity into Clarity

Deferred compensation may never feel as simple as a straightforward savings account. The rules, risks, and long timelines make it inherently more complex. Still, complexity does not need to be paralyzing. By focusing on what can be controlled, such as payout schedules, contribution amounts, and coordination with broader financial plans, executives can turn uncertainty into clarity. The goal is not perfection. The goal is a thoughtful strategy that balances current needs with future priorities.

Protecting What Matters Most

In the end, deferred compensation is about more than tax planning or income smoothing. It is about protecting the lifestyle, values, and goals that matter most to each individual and family. The decision to defer income is deeply personal, involving both rational calculations and emotional trade-offs. While no plan can guarantee certainty, informed decisions made with care can create confidence that tomorrow’s needs will be met. For professionals navigating complex financial lives, deferred compensation can be a valuable tool when used thoughtfully and in alignment with long-term goals.

Important Information: The Clifford Group LLC (“The Clifford Group”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where The Clifford Group and its representatives are properly licensed or exempt from licensure. The Clifford Group and its advisors do not provide legal, accounting, or tax advice. Consult your attorney or tax professional. For additional information, please visit our website at www.thecliffordgrp.com.